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Whitham Farms, LLC v. City of Longmont

Colorado Court of Appeals
2003 Colo. App. LEXIS 1323, 160 Oil & Gas Rep. 444, 97 P.3d 135 (2003)
ELI5:

Rule of Law:

An oil and gas lessor seeking to terminate a lease for breach of the implied covenant of reasonable development bears the burden of proving that a prudent operator would drill additional wells because it would be economically profitable to do so. A lessee does not breach this covenant by holding the lease without further development when all parties agree that drilling additional wells is not currently economically prudent.


Facts:

  • The dispute concerns three oil and gas leases on approximately 310 acres of land, with NARCO as the lessee and operator.
  • In 1982, NARCO's predecessor drilled the only well that exists on the property.
  • In 1990 and 1995, the City of Longmont and Whitham Farms, respectively, purchased the surface and mineral estates for portions of the land subject to the leases.
  • In 1997, NARCO recompleted the existing well, and it became a producing well.
  • In 1999 and 2001, Whitham Farms and the City of Longmont demanded that NARCO release the portions of the lease not necessary to support the single producing well.
  • Both the lessors (Whitham Farms and Longmont) and the lessee (NARCO) agreed that at the time of the dispute, it was not economically prudent to drill any additional wells on the leased property.

Procedural Posture:

  • Whitham Farms filed a lawsuit for declaratory relief against NARCO in a Colorado trial court, seeking to terminate an oil and gas lease.
  • The City of Longmont joined Whitham Farms' complaint in its answer to the suit.
  • The parties submitted the case to the trial court on stipulated facts and pretrial briefs.
  • The trial court entered judgment in favor of the lessee, NARCO, finding that the lessors had failed to establish a breach of the implied covenant of reasonable development.
  • Whitham Farms and the City of Longmont, as appellants, appealed the trial court's judgment to the Colorado Court of Appeals.

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Issue:

Does an oil and gas lessee breach the implied covenant of reasonable development, thereby justifying lease termination, when further development is not economically prudent and the lessee holds the lease in the hope that development may become profitable in the future?


Opinions:

Majority - Judge Carparelli

No. A lessee does not breach the implied covenant of reasonable development when further drilling is not economically profitable. The purpose of an oil and gas lease is the mutual benefit of both parties through profitable development. The 'prudent operator' standard dictates that a lessee's duty to develop arises only when there is a reasonable expectation that new wells would cover costs and return a profit. Because all parties stipulated that additional drilling would not be profitable, NARCO had no current obligation to develop further. The lessors argued that this unprofitability meant NARCO was holding the lease for speculation, which could justify termination. However, the court held that the burden of proof is on the lessor to demonstrate that the lessee is holding the lease for purely speculative purposes, which requires showing there is no potential for profitable development in the foreseeable future. The lessors failed to provide any such evidence, and therefore did not meet their burden of proof to justify cancellation of the lease.



Analysis:

This decision solidifies the 'prudent operator' standard in Colorado as the primary test for the implied covenant of reasonable development, placing a significant evidentiary burden on the lessor. It clarifies that a lessee is not required to undertake unprofitable operations to satisfy the covenant. The ruling protects lessees holding proven reserves during unfavorable market conditions, preventing lessors from using temporary economic downturns to terminate leases for alternative surface uses. For a lessor to succeed on a 'speculation' claim, they must affirmatively prove a lack of foreseeable profitability, not merely a lack of current profitability.

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